What Happens in China Does Not Stay in China

LONDON – This morning, a desperate message from our analyst in Beijing puts us in a lighthearted mood:

I’m sure you must have heard about the recent disaster in the Chinese stock market.

It’s my first time experiencing something like this. And it shocked me. It’s like the world is suddenly turning upside-down. Everyone is running for themselves.

People here feel hopeless, as they see so many government bailout plans fail.

There are so many rumors I can’t tell what’s true and what’s not. Some even said that it was U.S. capital shorting Chinese index futures.

Investors in U.S. stocks seemed to wake up yesterday with a start. They didn’t panic. But they were at least beginning to worry. The Dow dropped 261 points – wiping 1.5% off its value.

There is probably a lot more where that came – an opportunity on the downside.

To recap: Greece’s creditors have given Athens until midnight to come up with an acceptable reform plan.

Nobody knows what will happen. But Greeks are pulling as much cash out of ATMs as they can…

There have been lines at gas stations and food stores…

And Greek stocks are selling with as much as 20% dividend yield and just over two times earnings. This could be a (highly speculative) opportunity on the upside.

Meanwhile in China, investors have seen roughly $3.5 trillion in paper wealth evaporate over the last two months… as stock prices there plunged.

The Chinese are not sophisticated stock market investors. They have only been at it for a few decades. So, they tend to get over-excited in both directions.

It was only a few weeks ago that Chinese brokers were opening new accounts in record numbers. From farmers to hairdressers, everyone was itching to get a piece of the action, as the stock market soared.

A Gambler’s Market

It isn’t the first boom and bust for China. Between 2005 and 2007, Chinese stocks rose nearly 500%.

Then, too, the moms and pops rushed in, hoping to make their fortunes. In 2008, the market crashed, losing 73% of its value.

In the 12 months leading up to the peak of the recent rally, on June 12, Shanghai stocks gained about 150%. Now, the Shanghai Composite Index is down by just under one-third.

These ups and downs are great for seasoned investors. The idea is to buy low and sell high. What better place to do it than where prices go very high and very low?

When you are investing in stocks, you either earn returns as the companies you own equity in become more profitable, or you take returns from other investors.

So if you are hoping to make money in U.S. stocks, at current prices, you have a hard row to hoe. The economy is barely growing and corporate profits are already near record levels.

In China, there are more stock market gamblers than there are in the U.S. They buy too high and sell too low.

Overnight, Chinese stocks surprised to the upside – with a nearly 6% jump. It was the biggest gain since 2009. Most likely, though, it was not a genuine bounce; it was the result of government rigging.

In the past few days, the Chinese feds have unveiled a set of market interventions bigger than Washington’s TARP bank bailout package in the depths of the global financial crisis.

Investors tend to do dumb things in China; so do regulators.

In addition to cutting interest rates and reserve requirements for banks, regulators have suspended trading in roughly half of Chinese shares… eased margin requirements… ordered state-owned companies to buy back their own shares… and ordered state-owned banks to fund those buybacks.

And the government has warned the financial press – including our office in Beijing – not to say anything “negative” about stocks.

It’s even promised investors that the Shanghai Composite will hit 4,500 points – about 20% higher than where it stands today.

Another Front in the Zombie War

Of course, we never say anything negative. So when stocks fall, it is a positive thing.

It is an opportunity. It means you can get more value for your money. It also means fewer resources are drawn into the financial sector, leaving more for the productive economy.

The trouble in China has little to do with the stock market. The trouble is in the economy. It is managed, controlled, and centrally planned.

China is just another front in the Zombie War. The authorities there are under more and more pressure to hold onto their power, their money, and their status.

The result: too much debt and malinvestment.

And China’s zombie feds are using all the tricks in the book to try to prevent an economic slump – just like in the U.S., Japan, and Europe.

This has wide-ranging repercussions. China is the world’s biggest consumer of commodities. As colleague Chris Lowe reports below in Market Insight, that’s why a slowdown in Chinese demand is hitting commodity prices hard.

Global mining stocks have lost $143 billion – nearly 20% of their value – in the last 10 days. Crude oil prices have fallen, too. Some analysts now say oil will drop as low as $20 a barrel.

As we warned readers before, China could fall into a recession or even a depression.

And unlike Greece, China – the world’s second largest economy – will have a huge effect on the rest of the world.